Question #2
Reading: Reading 12 Evaluating Quality of Financial Reports
PDF File: Reading 12 Evaluating Quality of Financial Reports.pdf
Page: 1
Status: Correct
Correct Answer: A
Question
Alex Fisher, CFA, is examining the phenomenon of mean reversion on the earnings of several firms. Which of the following statements regarding mean reversion is least accurate?
Answer Choices:
A. High earnings should not be expected to continue indefinitely
B. Low earnings should not be expected to continue indefinitely
C. Normal earnings should not be expected to continue indefinitely
Explanation
When examining net income, analysts should be aware that earnings at extreme levels
tend to revert back to normal levels over time. This phenomenon is known as mean
reversion. As a result of mean reversion, analysts must understand that extreme earnings
(high or low) should not be expected to continue indefinitely.